Changing the landscape with digital tax

In a blink of an eye, Malaysia’s government has undergone a huge revamp since May 9, 2018 when our nation’s voters ended a 61-year old rule of the Barisan Nasional (BN) government by electing opposition party, Pakatan Harapan (PH), into power.

Since the momentous change, everyone has been bracing for many changes in the country including a digital tax that would mainly be focused on overseas service content providers.

And on November 2, the anticipation finally came to reality when Finance Minister Lim Guang Eng formally announced during the unveiling of the National Budget 2019, that foreign online service providers like entertainment streaming platforms such as Netflix, Spotify and Steam will be subjected to service tax effective from Jan 1, 2020.

Clarifying on the new tax, tax advisory Axcelasia Raxand Sdn Bhd managing director Leow Mui Lee guided that the tax, which stirred some shock reaction initially among businesses and consumers, is not imposed on all online transactions.

“This is incorrect as it will only be imposed on services paid to the online company or in application (app). Items under e-commerce have already been subjected to import duty and sales tax.

“For example, the user downloads a game that needs an in app purchase. These are the items that fall under the digital tax,” she was reported saying according to Bernama.

This taxation of mostly business-to-consumer (B2C) foreign entities is only the first tranche of the proposed digital tax as the government has further guided that they are waiting for the Organisation for Economic Cooperation and Development – along with more than 110 countries and jurisdictions – to come up with an agreed approach towards taxing the digital economy by March 2020.

While there is fear over the upcoming second tranche of the digital tax with little details out so far, the proposed first tranche has at least been received fairly well from many local businesses and analysts out there.

To level the playing field and to ride the digital wave

Historically, digital taxes for foreign entities have always existed in the form of a 10 per cent on services rendered by a non-resident taxpayer to a Malaysian resident, including online advertisements.

However, according to Jeremy Chew the senior content marketer for product meta-search platform, iPrice group, these businesses have often managed to avoid paying taxes in Malaysia by not having a physical presence within the country and only paying taxes where their company is headquartered in.

This loophole has caused a non-level playing field locally as many of these global players are able to provide better and competitive price points for their products and services than our local players who are subjected to local taxes such as the Sales and Service Tax (SST).

Chew believes that the this introduction of a digital tax would not only help level this playing field but also the playing field between online and offline businesses as well.

Additionally, many analysts and local stakeholders have also heralded this move as wise as the present digital economy in Malaysia has been growing rapidly in recent times – presenting itself as a huge potential of revenue for the government.

Games, music and videos: Malaysians go digital for entertainment

In order to understand how much Malaysians have shifted their entertainment habits to the digital world, we should first look at our gaming industry and how much it has changed in the past decade.

In the past, consumers mostly purchased games as physical copies from stores to be played either on their PCs or their purchased game consoles. These purchases contributed to our tax revenue as they were taxed just as any other merchandise sold within the country.

However, this is no longer seems to be the case as our local gamers have shifted their game purchasing habits away from traditional boxed and console games to digital copies of games from digital distribution platforms such as Apple App Store, Google Playstore and Steam.

In a report by The Malaysian Reserve (TMR), marketing analyst Newzoo reported that Malaysians had outdone all our Asean neighbours in terms of spending for online digital games with an estimated 14.0 million gamers in Malaysia spending a total of US$587 million or RM2.45 billion in app purchases, game purchases or downloadable content.

And Malaysia landing itself in the 21st spot of digital gaming markets around the world is expected to continue growing as the entire Southeast Asian region is expected to grow at an annual growth rate of 25 per cent up to 2020.

According to the report, Newzoo’s gaming market consultant Tom Wiiman guided that the most surprising statistic from their findings was that about half of the generated revenue or RM1.24 billion was on mobile games alone and that this followed the global trend.

“Digital game revenues will account for US$94.4 billion, or 87 per cent, of the global market – highlighting mobile to be the most lucrative segment, with the smartphone and tablet gaming industry growing 19 per cent year-on-year (y-o-y) to US$46.1 billion, claiming 42 per cent of the market.

“The mobile gaming industry will represent more than half the total games market by 2020,” said Newzoo.

And with mobile game purchases not being taxed, this is a huge piece of the pie that the government is missing out on.

Keeping our eyes on music

Besides just games, the sales of music have also shifted drastically as consumers are no longer opting to buy physical CDs but are instead opting to purchase tracks from digital distribution platforms or purchasing subscriptions from music streaming services like Spotify or Apple Music.

Spotify especially has taken a good hold over the music streaming market in Malaysia as Sunita Kaur its managing director for the Asia region has reported that Malaysians are among one of the most avid users of the platform in the Asia region with an average of 148 minutes played per day for each local user in 2017.

In total, this translated to over 7.5 billion minutes’ worth of music and 2.9 billion songs being streamed over the platform by Malaysians in 2017.

And it doesn’t just end there with music and podcasts, as statistics from popular entertainment video streaming platform, Netflix, have indicated that Malaysians were ranked the biggest binge watchers within the Asean region.

While there hasn’t been much solid figures indicating how wide spread the use of streaming platforms are right now, one thing for certain is that many industries like our telecommunications companies have picked up on this rapidly growing market and are very keen on servicing consumers with continual promotions of free trial subscriptions to streaming services, unlimited data for steaming or gaming services and implementation of breezy payment systems for in-app purchases of mobile games.

Little effect on consumers

Of course with all said and done, the group likely to be most devastated by the announcement of taxes on digital services would be ourselves, the consumers as we fear that the tax may raise prices for the digital entertainment and services that have become so ingrained in our lives.

But should the digital tax be able to “level the playing field” as Chew believes, analysts have also pointed out there is also the potential that the tax may spur both foreign and local companies to provide better services and offers to its users as competition heightens within the market.

Also weighing in on the effect the tax would have on consumers, KPMG Tax Services Sdn Bhd’s (KPMG Tax Services) executive director of Indirect Tax Dany Oon said he believed the tax would have little effect on the general public as free content can easily be found online.

“Do we really buy that much of online content? Not goods, but services, apps, music, videos, subscriptions, do we really pay for these?” he questioned, noting that even if users pay for such services, they will not really pay that much.

“I think the impact towards individuals, from an individual perspective, personally, I don’t think it is that much of an effect,” he sounded off during a KPMG Tax and Business Seminar 2018 held in Kuching.

Industry concerns

While the general consensus is that the digital tax will not end up being too much of an adverse factor for consumers, industry player iPay88 Holding Sdn Bhd believes that introducing the tax in the near-term may be detrimental to the growth of our digital economy.

In a media statement, the group’s executive director Chan Kok Long stated that it is currently far too early to impose a digital tax into our markets as our digital sector is still struggling to make profits.

“The fintech industry, for example, has made inroads in disrupting the financial industry and changing the way we do business yet the players are still investing in the business rather than making a profit.

“On the other hand, the marketplace is still in infancy stage in Malaysia and many companies within the digital industry are still trying their best to break-even. At the same time, these new tech companies are taking risks while continuously investing in research and development to stay ahead.

“Taxing them now may even push them to collapse or seek other countries as their base,” he argued while adding that the tax would also hinder innovation and growth of the industry.

He elaborated that the taxation of such a young and emerging industry would only cause players to look for greener pastures in neighbouring countries – ending up as losses for Malaysia.

A solution to this he suggested would be that the digital tax should be based on profit instead of industry.

“Tax is an important revenue for the government. However, instead of an industry based tax, the government should look at taxing based on profits.

“For example, international players should be taxed as they have established themselves and are able to expand into different countries. We believe that the government should set a margin based profit tax to enable the industry to mature into a fully developed economy.

“I hope the government will do an in-depth study into the industry and its challenges before implementing a digital tax without putting a barrier to the growth of the industry.”

Chan also touched on bottom tier SMEs, who are the backbone of the e-commerce industry.

“A considerable number of businesses on market places and social media are made up of small-time business owners like housewives and young entrepreneurs who just make a comfortable income, rather than millions in profit.

“They shouldn’t have to pay an additional digital tax. Instead the government should create incentives and soft loans so that this segment can benefit more from e-commerce,” Chan said.

In supporting the digital economy, Chan hoped the government will defer the digital tax introduction until the digital sector is ready and when many companies in Malaysia can successfully conquer overseas market. He also proposes for the government to form a new ministry to handle digital and technology.

“To help companies like payment gateways, data centres, logistics and marketplaces to build the digital ecosystem and infrastructure, we urge for the government to provide tax incentives in the upcoming Budget 2019,” Chan said.

Second in SEA, helping pave the way for the rest

With the decision to begin taxation on global digital businesses, Malaysia has become the second country in Southeast Asia (SEA) to consider doing so, right after Singapore.

Our two countries are both expected to begin implementing the tax come Jan 1, 2020, potentially alongside EU nations who are currently in the midst of heavy debate on how their digital taxes will sway.

As mentioned before, the federal government has guided that additional digital tax components may be rolled out in March 2020, following guidance from OECD as they are currently studying the issue.

While it is still unclear on how the digital taxes may end up being implemented in the EU, a report by tax advisory Ernst Young (EY) entitled “Scaling the digital divide” indicated that the current debate of digital tax is not about large corporations earning stateless income or avoiding taxes, but rather, it is about the division of tax rights among countries who consider that their citizens contribute to the profits made by some digital focused companies.

Proposals to scale the digital divide

To this end, the OECD has released two proposals back in March 2018 that they believe will help scale back this digital divide by imposing increased tax costs and compliance burdens for many global digital businesses around the world.

The first ‘interim’ proposal is to implement a 3 per cent digital services tax (DST) on gross revenues from activities in which users are deemed to play a major role in value creations.

According to EY, the definition of these activities would be targeting digital advertisers and platforms acting as online market places whose tax statuses are often murky.

Young start-ups however will not be impeded by the tax as the commission has proposed that criteria of an annual worldwide revenue of 750 million euros or more or annual EU taxable revenues of 50 million euro need to be met before an entity can be subjected to the tax.

The second longer-term proposal, is broader scope of taxes on over 50 different digital activities. A company deemed to having a “significant digital presence” would be classified as a digital permanent establishment. These new classifications are intended to establish a taxable nexus alongside a revised profit allocation rules to determine how taxes on digitally-derived profits are distributed among countries.

While in theory the proposals do sound like the right move for us to evolve our tax laws in the new digital era, the OECD efforts have been met with much resistance from lobbying industries and uncompromising countries.

This has ended up in several countries and zones backing out from the proposed digital taxes or proposing their own take on the issue.

An important step for Asean

Because of this uncharted territory, iPrice’s Chew believes that Singapore and Malaysia’s take on digital tax will be a very important step for the ASEAN region on how digital taxation laws will eventually be formed.

“All eyes will be on Singapore and Malaysia by 2020, as neighbouring countries will closely observe the successes and pitfalls of its implementation and will probably introduce a digital tax of its own. If successful, it won’t be long when the digital tax will become a conventional thing in the global digital sector,” said Chew.

Jeremy Chew

During this turbulent time before implementation of digital taxes across the global, tax advisory EY advises digital companies to: “begin viewing their existing digital activity and pipeline projects with a new lens, and to bring tax into the conversation.”

“Digital tax issues may also need to be incorporated into investor communications. Investors need to know about tax issues related to digital activities that may reduce profits if these taxes go into effect.

“They also should be informed about the possibility and potential impact of restructuring parts of a digital strategy or even the need to exit lines of business or markets completely depending on how tax proposals advance.”

Regardless of how the situation sways, Chew believes that it is very unlikely that the Malaysian government will end up side-lining our e-commerce and digital industry due the huge potential and growth is presents to our economy.

“The digital economy presents a great growth opportunity for Malaysia especially when the government is looking to optimise their expenditure to manage its RM1 trillion debt.

“Not to forget that the country’s focus to developing the digital sector was initiated the Dr Mahathir himself during his last outing as a Prime Minister back in 1996 with the Multimedia Super Corridor (MSC) initiative,” he added.